How tax policy can expand opportunities for everyone, not just the few

When one looks at growing inequality in earnings and wealth, it’s wrong to think this is only an issue of the “top 1 percent.”  The way government tax subsidies are allocated also play a role.

Elected officials love to  talk about expanding opportunity in America, but few do anything about it.  And in a recent report I found that spending for those federal programs that do aim to promote opportunity for all, such as work incentives and support for education, are on a path to shrink as a  share of  government resources.

This isn’t about the size of  government. Total government spending and tax subsidies are on track  to grow by almost $15,000 per household in ten years. It is rather, about how government allocates those dollars. Government programs other than public goods like defense come in two general forms:  In one bucket are those that promote opportunity by expanding  earnings and wealth, as well human and social capital. In the other, income maintenance programs attempt to help working age people achieve a minimum level of current consumption or help sustain the pre-retirement consumption levels of older adults. Thus, wage subsidies differ from welfare, and spending more money on education is not the same as providing additional years of retirement support.

It’s not that we don’t spend on opportunity-enhancing programs. About $1.3 trillion, equal to 7 percent of GDP or about one-quarter of total expenditures and tax subsidies combined, fall into this category.  This may sound impressive, but nearly 80 percent of 2016’s expenditures on opportunity are  tax expenditures. While some, such as the earned income tax credit (EITC), help  low-income workers, most tax subsidies largely benefit upper-income households.

By largely excluding those with low- to middle-incomes, tax subsidies for activities such as paying mortgage interest or saving for retirement fail to promote opportunity for all. Worse,  many fail to  promote very much opportunity for anyone. For instance, as far back as 1984, my TPC colleague Harvey Galper and I found that tax breaks for retirement savings did little to  encourage  new saving. In 2012, Raj Chetty found that little has changed.  So while these programs might favor opportunity in some broad sense, they fail to promote opportunity for all.

Looking ahead, support for low- and moderate-income households, such as  the EITC, is on track   to decline  as a share of the budget while the non-inclusive programs such as housing and retirement  tax subsidies are expected  to grow. This is likely to happen under almost any set of assumptions, as almost all growth goes toward areas that few would classify as promoting opportunity for all, especially at the margin.

When one looks at growing inequality in earnings and wealth, it’s wrong to think this is only an issue of the “top 1 percent.”  The allocation of government tax subsidies and direct spending also affects inequality over time, in no small part by the efficiency with which it promotes opportunity.

Government could fix this tax part of this problem by redesigning subsidies for housing and retirement to make them both more inclusive and more successful at their ostensible goal of expanding  homeownership and retirement saving wealth in the economy as a whole.

Homeownership subsidies could be reduced for second loans that mainly finance current consumption, second homes, or the ever-better housing that each generation pursues. At the same time, a first-time homebuyer’s credit could be extended throughout the population, thus making the system far more inclusive.

Similarly, there are various ways to channel a greater share of retirement tax subsidies to low- and moderate-income households, including a larger retirement-oriented savers credit and tighter restrictions on employer-sponsored plans that fail to extend benefits to most employees.

Economists on the left, right, and everywhere between generally support these reforms. Yet, lawmakers rarely act. By recapturing control of our fiscal future, and being willing to remake fiscal policy to focus on promoting opportunity for all, lawmakers could turn that goal from mere words to reality. 

This article first appeared at TaxVox.